Comparison between Flat Rate vs Reducing Rate
| Rate Type | EMI Per Month | Total Interest Paid | Total Amount Paid |
|---|---|---|---|
| Flat Rate | |||
| Reducing Rate |
Flat Rate : Repayment Schedule
| EMI Number | Date of Payment | EMI Amount | Principal Repaid | Interest Paid | Principal Remaining |
|---|
Reducing Rate : Repayment Schedule
| EMI Number | Date of Payment | EMI Amount | Principal Repaid | Interest Paid | Principal Remaining |
|---|
Understanding Flat Rate vs. Reducing Rate EMI: Which is Better?
When you’re considering taking a loan, one of the most important decisions you’ll face is choosing between a flat interest rate and a reducing balance rate. Both methods calculate the interest you pay, but they do so in different ways, impacting the total amount you’ll end up paying over time. Let’s dive into the details to help you make an informed choice.
What is Flat Rate Interest?
Flat rate interest is the simpler of the two methods. Here, the interest is calculated on the entire principal amount throughout the loan tenure. This means that even as you make repayments, the interest continues to accrue on the original loan amount.
Flat Rate EMI Formula:
EMI = (Principal + Total Interest) / Loan Tenure (in months)
Where:
- Total Interest =
Principal × Rate of Interest × Loan Tenure (in years)
For example:
If you take a loan of ₹1,00,000 at a flat rate of 10% for 5 years, the interest will be calculated on ₹1,00,000 for the entire duration of 5 years, regardless of how much you’ve already paid off.
- Pros: Simple to understand, with fixed monthly payments.
- Cons: Can be more expensive over time because the interest does not decrease as you repay the loan.
What is Reducing Rate Interest?
Reducing rate interest, also known as diminishing or declining balance rate, is more complex but often more economical. Here, the interest is calculated on the outstanding loan balance, which decreases as you make repayments. This means you’re only paying interest on the amount you still owe, not on the original principal.
Reducing Rate EMI Formula:
EMI = [Principal × Rate of Interest × (1 + Rate of Interest)^n] / [(1 + Rate of Interest)^n - 1]
Where:
- n = Loan Tenure (in months)
For example:
If you take a loan of ₹1,00,000 at a reducing rate of 10% for 5 years, the interest will be calculated on the outstanding balance after each repayment. As a result, your interest payments decrease over time.
- Pros: Typically results in lower total interest paid over the loan’s tenure.
- Cons: Monthly payments can vary, which might make budgeting a bit more challenging.
Example Calculation
To illustrate the difference, let’s consider a loan of ₹1,00,000 over 5 years at 10% interest:
- Flat Rate EMI: Your EMI remains the same, but you end up paying more interest overall.
- Reducing Rate EMI: Your EMI decreases over time, and you save on interest.
In summary:
- Flat Rate: Higher total interest, easier to calculate.
- Reducing Rate: Lower total interest, but payments vary.
Conclusion
Understanding the difference between flat rate and reducing rate loans is crucial for making a sound financial decision. Always calculate the total cost of your loan and consider how each option fits into your budget and long-term financial plans. With this knowledge, you’ll be better equipped to choose the loan that’s right for you.